Crossing the Digital Divide: A Transition Baedeker

From Wal-Mart to Amazon, great companies have always faced the challenges of channel conflict, pricing and cultural change.

It's a new economy success story - a tiny company emerges unexpectedly with an unorthodox business plan that rewrites the rules of retailing, and in the process drags entire industries across a radically new frontier. In its dust, some of the world's largest store-owners - as well as mom-and-pop outlets on Main Street and in strip malls - scramble to recast their strategies or risk losing out completely to this untraditional rival.

The Amazon.com saga? Not quite; it's Wal-Mart Stores. But the obvious parallels between the retailer and the e-tailer demonstrate that many of the same critical issues - corporate culture, channel management, pricing, branding and innovation, to name a few - are at the core of every business discontinuity.

Consider the similarities between Wal-Mart's discount-store model and Amazon.com's e-business model. Both were built on fresh relationships with suppliers and new pricing structures. Both used customer databases to target items at specific groups and individuals. Both leveraged rapidly expanding product lines, untapped retailing locations and technology-driven distribution networks. Both were driven by visionary C.E.O.'s who saw innovation as an advantage, not a risk.

Moreover, just as Amazon.com's ancestor is Wal-Mart, Wal-Mart Stores Inc. can trace its lineage to revolutionary five-and-dimes and department stores, like F.W. Woolworth & Company, that transformed retailing decades earlier. Indeed, in the Woolworth-to-Wal-Mart-to-Amazon.com evolution, it is clear that business transformations are not isolated end-games, but a logical, albeit spasmodic, progression of relentless change.

That is not to say that e-business isn't unique. In many ways, it is a more radical business "disconnect" than any before, mainly because of the frenetic pace and seemingly unlimited potential of Web technology, and the newly disintermediated relationships between buyers and sellers. But the individual differences among industrial dislocations don't negate the importance of the similarities. And by examining the lessons companies learned as they grappled with prior business upheavals, managers and strategists at traditional firms can develop sound strategies for dealing with structural change today, and with the inventive upstarts reshaping their industries. Meanwhile, by exploring prior transformations, dot-coms can identify the fundamental business strategies and capabilities that helped earlier innovators survive beyond the startup stage.

Consider the retailers suddenly faced, circa 1970, with dozens of Wal-Mart stores - bright and clean outlets offering rock-bottom prices and product lines wider than anything imaginable at the time - as analogous to offline companies today. Stores that met Wal-Mart's threat and have even flourished since then - higher-priced chains like The Gap, department-store retailers like Nordstrom's, and category killers Toys "R" Us, Home Depot and Staples - did so because they freely imitated parts of Wal-Mart's formula. They deployed data-gathering technology, or used massive sales volume to squeeze the best prices out of suppliers, or developed just-in-time inventory management systems to respond to their customers' buying preferences.

Numerous other retailers were too slow or too hidebound to implement - or, in some cases, even understand - Wal-Mart's approach. Among them were once powerful names like Gimbel's, Korvette, Caldor, Alexander's and Montgomery Ward. All failed to develop successful computer-based inventory, customer-tracking and distribution systems. They were often short of products that consumers wanted or had too much of what wasn't selling. In short order, many simply went out of business.

Meanwhile, Wal-Mart, instead of resting on its triumphs, continued to evolve, taking pages from its best rivals' business plans. As customer service became a value proposition for big retailers, Wal-Mart improved its service, too, so as not to be marginalized as a bare-bones discounter. And as category killers emerged, Wal-Mart struck back, especially in such areas as toys and appliances, by making its suppliers even more dependent - setting up satellite data feeds and opening up more stores to increase sales volume. As a result, Wal-Mart was able to continue to undercut rivals' prices, even those offered by category killers, for virtually every product, and still hold margins steady.

Captured in this retailing tug-of-war (which is still going on and has even escalated with the introduction of e-business) is a real-world lesson that's applicable to any industry facing a business discontinuity: Both the innovators and threatened incumbents have to continually adapt, like a competitive and evolving ecosystem, by mimicking or countering each other's most successful strategies. To do this well, companies must examine the separate business issues influenced by the dislocation and adjust their strategies to fit the new paradigm.

The following sections explore significant business discontinuities resulting from e-business and provide real-world formulas taken from prior dislocations for dealing with each of them.

CORPORATE CULTURE

Adaptation can be driven only by a corporate culture that breaks through resistance to change. This is especially true in e-business, in which lower barriers to entry, the rapid pace of change, and the continual emergence of new rivals require companies to react with breakneck speed to customers and competitors. Such cultures champion innovation and flexibility, and disdain the turf wars and self-preservation schemes that trap incumbents in losing positions.

The short history of e-business includes many companies that were too rigid to respond quickly to the Web's disordering influence on their industries - and found themselves in a potentially unwinnable game of catch-up.

Merrill Lynch & Company, for instance, resisted Web-based brokerage services for four years, while companies both new and extant, such as E-Trade, Charles Schwab and smaller discount brokers, stole its customers away by offering an efficient, inexpensive approach to buying and selling stocks. Merrill's public antipathy to the Internet was so strong that in August 1998 its vice chairman and brokerage chief, John "Launny" Steffens, said Internet trading "should be regarded as a serious threat to Americans' financial lives."

Merrill's paralysis, though, had nothing to do with protecting the citizenry; it was stoked by an internal culture clash. The company's powerful cadre of 15,000 brokers saw its commissions, which averaged nearly 30 percent of gross production, threatened by Internet trading and lobbied hard against it.

Merrill is far from the only high-profile company stymied by its own culture. When Amazon.com opened shop on the Internet in 1995, Barnes & Noble Inc., which had just gone through a feverish period of growth that included the debut of its innovative cafes and music shops within supersized bookstores, didn't take e-tailing seriously. Internally, the emphasis was so rooted in expanding the bricks-and-mortar chain that any other sales channel just didn't make the radar screen.

The two-year delay between Amazon.com's launch and the somewhat halfhearted debut of Barnesandnoble.com proved damaging. Even after Barnes & Noble set up its site, Amazon.com was so far ahead on the Web, illuminated by glowing press and identified with positive business values like strong customer service, innovation and fully stocked shelves, that customers continued to prefer Amazon.com. Meanwhile, Amazon.com built on its initial success to position itself as the No. 1 e-tailer overall, adding products like electronics and toys. The result: Barnesandnoble.com sales of books for the past year were still under $200 million, while Amazon.com's broader business generated revenues well over $1 billion.

Merrill Lynch and Barnes & Noble should have learned from the example of NBC, which achieved a rapid, hard-fought cultural transformation after its 1986 acquisition by the General Electric Company.

Although network television grew out of an earlier media platform, radio, by the 1980's the Big Three networks, after years of living in what seemed like a protected distribution oligopoly, had grown complacent about their market positions and had largely lost any interest in alternative distribution schemes. Indeed, network operations were structured around relations with affiliate stations, which were compensated handsomely by the networks in return for acting as programming and advertising conduits to local audiences. Because of their protected positions, the networks' profit margins tended to be high and stable, and their spending lavish.

When Robert Wright, then a 43-year-old attorney and head of G.E.'s finance division, took charge of NBC after the merger, he understood that the ongoing erosion of the network television audience required him to push the company into new forms of distribution, and to grow earnings - not just cash flow - at the same time.

The task was arduous, not least because NBC, the oldest television network, was No. 1 in the ratings when G.E. took over, and its senior managers bridled at the mandate for change. Relying on a small cadre of executives, including both young outsiders and visionary insiders, Mr. Wright drove the company into cable and later onto the Internet, all the while training them to look at NBC as a brand, not merely a broadcast network. Executives were rewarded for identifying acquisition targets or developing new business ideas that extended that brand. Those urging complacency were eased out. When affiliates chafed at the network's move into competitive media, the new, toughened NBC held firm against their opposition.

Thirteen years later, the cultural transformation is complete, and the results are clear. The NBC brand stands atop more than a dozen analog and digital networks. The company is among the top three owners of cable programming services. Its success in new media, combined with its prowess and luck in the broadcast business, make it the most profitable network company by far. By grasping early the need for cultural change, NBC was able to get a jump on network rivals that remained mired in conservative, diseconomic habits.

The same forces are at work today in financial services. Merrill Lynch eventually had to cave in to the inexorable growth of online trading, even if its corporate culture wasn't ready to accept it. Last June, Merrill announced a complex plan that set Internet transaction fees at about $29.95 per trade, on a par with Charles Schwab.

Although Merrill has won plaudits for the quality of the online strategy it has disclosed, the company's halting approach to e-business is still hurting it. Its online trading site, which opened in December 1999, is not expected to be fully functional until mid-2000. Meanwhile, other Internet brokers continue to cement their presence on the Web, signing up new customers - some of them formerly Merrill's. To rally brokers around its Internet strategy, Merrill has agreed to pay them the commissions they lose from Web trading for the next five years, an amount that could total hundreds of millions of dollars.

Merrill's Internet delay is reminiscent of how the giant brokerage firm handled its significant business dislocation 25 years ago, when the U.S. Securities and Exchange Commission outlawed industry-wide fixed commissions. Merrill, like most of its competitors, used this as an opportunity to raise transaction fees. Schwab took the other route and slashed commissions, in effect creating the discount brokerage model. Schwab's idea was not unlike that adopted by Internet brokers: Attract customers with bargains on transactions, which are essentially commodities, and make money on volume as well as sales of initial public offerings, research reports, asset-allocation advice, mutual funds and, more recently, investment banking.

Merrill, meanwhile, held off cutting commissions for as long as it could. By the time Merrill launched its less-expensive Web-based trading programs, Schwab and numerous other discount brokers were well established - and much more efficient moneymakers. In 1998, Schwab's pre-tax profit margin was 18 percent, compared with only 9.5 percent for Merrill and 10.7 percent for the entire brokerage industry. Equally impressive, Schwab's return on invested capital was about five times the industry average, while Merrill's had fallen behind its competitors.

Schwab was far from the first broker to offer online trading - it started in 1996, about four years after E-Trade Securities Inc. pioneered the concept on the CompuServe online service - but unlike Barnes & Noble in its battle with Amazon.com, Schwab quickly outpaced its Internet rivals. Schwab's culture was prepared for change and not hardened against it. As the discount brokerage forerunner, Schwab was born from innovation: Its commission schedules were already tied to inexpensive trades, and it had extremely advanced, cost-effective networking technology that powered its vast telephone and electronic trading systems. These cultural and infrastructural strengths were indispensable in making its Web presence a success. Without hand-wringing and cultural resistance during its preparation to launch an Internet site, Schwab could focus on deploying an online trading system that would match customer expectations. Schwab has captured 42 percent of all assets traded online, even though its transaction price - $29.95 per trade - is among the highest in the category.

CHANNEL MANAGEMENT

Companies like Merrill Lynch that avoid alternative sales channels tend to lean on the same reason: They don't want to cannibalize their more lucrative existing business and wreak havoc on their pricing structures. Such companies see their current business as being under siege. Moreover, manufacturers - whether they make clothing, shoes, record albums or farm equipment - are also wary about upsetting their retailing or distribution partners by selling directly via the Internet.

In the move to the Digital Age, as in prior transformations, these excuses are shortsighted. For one thing, resisting e-business does not slow it down. Whether an offline company participates on the Net or not, there will be any number of Web-based outlets that compete with it. Beyond that, opening up new sales channels, while potentially upsetting to both the internal culture and existing distribution networks, is almost always a desirable strategy that can pay off with new customers and new ways to leverage their purchases.

Companies like Nike and Levi Strauss & Company tested this thesis in the real world when they opened their eponymous retail outlets in the early 1990's. Nike Inc. was riding a wave of popularity and had just supplanted Reebok International Ltd. as the No. 1 sneaker company when, in 1992, it determined to build on its new market power by opening the first of its 13 NikeTown superstores. The move not only surprised its rivals, but effectively put Nike in competition with its own retail channel - especially key accounts like Venator Group's Foot Locker and The Sports Authority.

To quell tension, the sneaker maker took pains to assuage the concerns of its retailing partners and to convince them that adding a new sales channel would benefit both Nike and the storeowners, because it would drive increased awareness and promotion of the Nike brand. More aggressively than ever, the company advertised its entire shoe line - with its Michael Jordan and "Just Do It" campaigns - and paid millions of dollars to place its swoosh logo prominently on uniforms, billboards and other spaces at virtually every sports event, big and small. Nike also took the canny step of barely promoting its own stores, which would have inflamed retailers. Moreover, the company favored its top retailers with extra early looks at new models, and made lines exclusively for them, such as the Foot Locker Flight 65 and Flight 67. It also built a unique "futures" just-in-time inventory program that allowed retailers to place orders as early as six months in advance, with a guarantee that 90 percent of the order would be delivered within a set time at a fixed price.

Of course, a portion of the retailers' fear was entirely justified: It was inevitable that Nike's new stores would eat into some of their business. Had Nike not addressed their concerns, they could have retaliated by refusing to carry some of its lines. But the combination of its enormous marketing drive and the retail program staved off reprisals. By 1999, only about 60 percent of Nike's revenue was coming from its 20,000 retail outlets. Yet Nike's revenues, even after two years of declines, are up 158 percent overall since the first NikeTown opened - growth that has also benefited the company's third-party retailers, who have seen their Nike sales climb about 10 percent annually during the past seven years.

Levi Strauss, for decades a fixture at department stores, took a similar tack when it opened its first company-owned outlets in 1991. The jeans-maker continued to share customer data and just-in-time inventory systems with its retailing partners. It didn't cut back on collaborative selling and marketing programs with the big retailers that sustained Levi's success before a bruising price war with discount manufacturers sent its sales plummeting in the last couple of years. As with the sneaker retailers, department stores like J.C. Penney and specialized clothing outlets like The Gap continued to profit from Levi's jeans for much of the 1990's and were barely affected by Levi's stores.

Essentially, both Nike and Levi's understood that as new sales channels are opened - and again, it is always advantageous when they do - old ones should not be allowed to wither away. Otherwise, a company is just replacing one channel with another and not increasing sales by giving customers additional opportunities to buy products.

This lesson is critical as both manufacturers and bricks-and-mortar retailers enter the e-channel. Almost everything that Nike and Levi's did in the bricks-and- mortar world - sales and inventory data-sharing, exclusive manufacturing and distribution relationships, co-branded advertising, directing customers to retail locations for special promotions - could easily be translated into the online sales channel.

Which is what makes Levi's recent Internet misstep so unexpected.

In late 1998, Levi's announced that online sales of its jeans would be restricted to its own Web site, a move that barred its bricks-and-mortar retailing partners from selling Levi's goods at their virtual stores. Angered by Levi's unilateral Net move, retailers fought back by giving Levi's less prominent display space in their physical stores, skimping on promotions for its jeans and trimming inventory. In trouble already - revenue had fallen 19 percent since 1996 - Levi's couldn't afford further damage. So last October, Levi's caved in, announcing that after the 1999 holiday season, it would stop selling any merchandise on its Levi's and Dockers Web sites; it would leave that to its retailing partners. By its aborted e-tailing foray and its extremely public attempt to pre-empt its long-time retailers, Levi's not only lost sales in its traditional channels for more than a year, but also fumbled an opportunity to open up numerous new Web channels for its products.

With so many real-world companies struggling with the fear of cannibalization by the Web, it would not have been surprising if newspapers had followed suit and avoided the Internet as a new sales channel. The newspaper business model is to attract readers from a geographic area with words and pictures, drawing revenues from circulation and from advertisers targeting these readers. Electronic versions of newspapers, which to this point have largely been offered free of charge on the Internet, could conceivably crimp the print product's circulation, cutting into both circulation and advertising revenues, with little certainty that Web advertising sales would make up the difference.

This scenario was nothing new for the newspaper industry, though. For years, circulation had been dwindling as local television news, electronic databases and then the Internet stole portions of newspapers' audiences. Some publishers made up for this drop in readership by redesigning their publications to downplay general news, putting a greater emphasis on features and departments covering lifestyle, business, sports, science, technology, medicine and entertainment - areas that television could only tackle in short bursts.

This approach worked for many newspapers. They were able to generate increasing retail and national advertising - the latter once a negligible sales category for them - targeted at this special coverage. This more than overcame the loss of advertising revenue that had begun as a result of decreasing circulation. Typical are the results of No. 1 newspaper chain Knight-Ridder Inc., which puts out 31 dailies, including the Philadelphia Inquirer and the Miami Herald. After flat or falling revenues in the mid-1990's, Knight-Ridder's revamped newspapers reported record earnings and sharp sales growth in 1998 and 1999, even as Knight-Ridder sought to build a commanding presence on the Internet.

Moreover, to hold costs down, newspapers during the past few decades finally overhauled their aging editorial and production systems. They installed digital printing networks that automated copy flow from writer to typesetter, with online editorial processes and linked databases of archived stories and other relevant information.

Just as Schwab's early adjustment to a discounting environment prepared it for the later advent of electronic trading, and as NBC's new culture of deal-making helped it forge the alliances necessary to make it on the Internet, the newspaper industry has benefited from its early embrace of discontinuity. By introducing focused editorial content, electronic editorial processes and database/networking technology, newspapers that might have fretted about cannibalization and weak infrastructure instead have been able to port specialized content easily to a medium that typifies customized infotainment for niche audiences. Today, every major American paper and most important non-American papers have Web sites, and most are counting heavily on them for future growth.

In other words, if the Web is going to cannibalize the audience and drive down circulation revenue, it might as well be used to keep the audience secured to the brand, thereby maintaining the ability to sell the brand to advertisers and branded services to audiences. While electronic newspapers could eventually replace the print versions, they can also support print's continued existence. Just as NikeTown buoyed brand awareness for Nike sneakers and drove customers to other retailers as well as Nike's stores, Web newspapers will likely sustain the print product by promoting it to a wider audience - including young readers who have grown up without the newspaper habit.

At the same time, by adopting the e-channel, newspapers are also riding the Internet investment updraft. After languishing for much of the past decade, the stocks of most newspapers with significant Web presence have risen sharply during the last few years. Through the first 11 months of 1999 alone, The New York Times Company's shares were up 35 percent, Dow Jones & Company's stock price rose 42 percent, and Tribune Company shares soared 71 percent.

The central concept here is adaptation. The best newspapers do not merely publish their existing content on the Web; instead, they have employed the Internet's interactivity and search capabilities to design electronic publications that are more like catalogues serving demographic and psychographic categories. Thus, the New York Times' New York Today site (www.nytoday.com) is made up of reviews, articles and lists related to restaurants, movies, theaters, museums, getaways, hotels, shopping, art galleries and sports. There are also classified ads for real estate, jobs and autos that can be searched, as well as personalized calendars and customized news. Almost every major newspaper chain is setting up similar sites in different cities. Knight-Ridder, for instance, operates 45 Web sites under the banner "Real Cities."

Microsoft, America Online and Yahoo set up similar city sites, but they haven't been able to compete with the resources, breadth, editorial expertise, archived and current news, and content-delivery skills that newspapers have - all of which evolved offline. While Microsoft and AOL have both cut back on staff and coverage in their local sites, The New York Times reported a 75 percent increase in revenue from the Internet in the third quarter of 1999 - to $7.4 million from $4.2 million a year earlier. The number of registered viewers for The New York Times on the Web increased to 8.7 million versus 7.8 million in mid- 1999. Knight-Ridder's Internet ventures were on pace to bring in more than $40 million in revenue in 1999 compared to almost nothing the year before.

PRICING

Tied closely to Internet revenue growth and to actually making money in e-business is the ticklish issue of pricing. Because the connection between buyers and sellers is more direct on the Net than in bricks-and-mortar outlets, the supply-and-demand equation can, in theory, be adjusted continually to market conditions. Deep discounting by even a few companies can instantly alter market-price expectations. More often than not, much to the dismay of traditional companies, the outcome has been dramatically lower prices and margins. It has also resulted in companies playing a game of "can you top this" as they willingly turn their products into commodities and loss leaders to attract customers, in the hope of generating income eventually by selling Web advertising space, customer data or Web access.

Nowhere is this commodity conundrum more evident than in the computer industry. The price of personal computers has been falling almost since the Apple IIe, Radio Shack TRS-80 and I.B.M. PC were released in the early 1980's. But the pricing downdraft has accelerated dramatically with the advent of the Internet, which produced dozens of companies selling PC's online. To break through the din, a number of flashy pricing strategies have been introduced to attract consumers. For instance, companies such as Egghead.com's Onsale unit and eMachines Inc. sell full-fledged PC's for a mere few hundred dollars when customers sign a three-year contract with a specific Internet service provider. And Free-PC, which recently merged with eMachines, has been offering computers at no cost in exchange for the right to track Web usage and deliver customized ads to customers' desktops.

These are only the most radical examples of the pricing discontinuity on the Internet that has led some to envisage the day when a site called Onebuck.com will "sell" a dollar bill for 75 cents, with a business model structured to generate the difference from advertising. Though One- buck.com may sound extreme, that same kind of pricing threat is, in varying degrees, affecting almost all e-businesses. As more and more e-tailers enter the selling space, the sheer imbalance on the supply side and the desperation to woo customers to their sites is continuing to push prices down.

Not surprisingly, we've seen this situation before. When endless rounds of discounting threatened both manufacturers' and retailers' margins in the mid-1980's, Sam Walton introduced an innovation known as "everyday low prices." Wal-Mart and other category killers like Circuit City popularized the idea in the 1980's with their promise of no more sales, just discounted products year-round. The offer resonated with consumers, who were wary that discount promotions on individual items were not the bargains they claimed to be. Consequently, Sears, Kmart, Target and Montgomery Ward, among numerous other chains, quickly followed suit.

Before long, supermarkets like Safeway, A&P and Albertson's were forced to adopt everyday low prices, pressured by big manufacturers like Philip Morris, Procter & Gamble and Colgate-Palmolive. The consumer products companies saw everyday low prices as a way to stop the relentless coupon wars in which they were mired, a downward spiral that was tarnishing the value of their brands and wreaking havoc with profit margins. To them, everyday low prices was a means to buoy prices. Their strong brands, supported by years of advertising and consumers' trust, would be able to resist the siren call of generic products and store-branded goods, and maintain their price differential over time. The perception of added value can frequently hold the line against commodity pressures.

Surrounding a brand with the aura of added value was not limited to coffee and corn flakes manufacturers; it also proved applicable in retailing and other service industries. For instance, Nordstrom's differentiated itself from - and charged more than - Kmart, because it offered valet parking, personal shoppers, overnight delivery of unusual sizes and higher-quality products. In like fashion, for customers who pay higher insurance premiums, the Progressive Corporation provides special services, such as claims adjusters who arrive at accident scenes in vans outfitted with a mobile phone, refreshments and a place to calm down.

Adapting this high-value, high-quality brand approach to e-business pricing is one of the topics explored in the book"

The Dell Computer Corporation is a good example. As PC prices fell precipitously, Dell refused to discount. Instead, it offered customers computers built to their unique specifications, machines that were consistently top-rated by Consumer Reports magazine. Additionally, Dell made its reputation on excellent technical support, fast delivery and a strong customer service network. The result: Though Dell has always charged as much as or more than other PC makers, it rose to No. 1 without compromising its high-value direct-sales approach.

Marriott International Inc. tried a similar tactic on the Internet. On average, the hotelier charges more for rooms booked through the Web and justifies this by offering additional amenities, like specialized maps of attractions around the hotel, express booking nationwide, route maps and interactive vacation planners.

And to rise above its own price war, Levi's is selling custom jeans for about twice the price of those from rival companies like the VF Corporation, which makes Lee and Wrangler jeans. Customers can order these pants at Web-connected kiosks at Levi's stores as well as Levi's other retail outlets. Customers receive the jeans within three weeks. The pants cost $55, or about 35 percent more than a traditional pair of Levi's. Today, almost one-fourth of the jeans sold to women at Levi's stores are customized - one of the few bright spots in a dismal five-year period for Levi's when overall revenue has plunged and the company has closed one-third of its North American plants.

As fresh as these strategies are, they only hint at the Internet's potential to transform pricing from a static to a dynamic model. For that, online product auctions come much closer. Because of the Net's ability to disintermediate many of the middlemen, who typically link buyers and sellers, companies can use online auctions to charge exactly what the market will bear at the moment of the sale.

In some cases, this means not having to staff teams of salespeople to tout goods of diminishing value, or turning over aging products to liquidators who pay pennies on the dollar. Instead, by dealing directly with buyers in a bidding environment, sellers can pocket the cost savings and increased revenue, almost certainly coming out ahead. These auctions are well-suited to the Net, because unlike the real world, there are no constraints on place and time. Buyers and sellers don't have to physically travel to attend these auctions, and they can be held over a period of days or weeks without inconveniencing anyone.

Lands' End Inc. was one of the first companies to try a version of this on its Web site. Through a game called "On the Counter," 25 new, overstocked products are listed at discounted prices every Saturday. They are then marked down each day through the week until sold out. For consumers, the sport is to hold out for the lowest price before the items are gone. Lands' End gains three distinct advantages from "On the Counter": Old inventory is turned into sales more quickly than it would be through a catalogue; in almost every weekly game, all products are sold out and sold at higher prices than if Lands' End had simply dumped them in an online or offline discount bin, and customers come back to the site daily - giving Lands' End opportunities to market other items to them. (Lest we think this is a new phenomenon, just look back to the Syms Corporation's dated, progressive markdown tags.)

Other e-tailers have gone much further, using an even more dynamic direct-auction model to sell and price products online. The PNC Bank Corporation has allowed customers at its Web site to bid on the interest rate of 50 one-year, $5,000 certificates of deposit, with the CD's going to those asking for the 10 lowest rates. The winners all bid rates greater than 6 percent, which was higher than what PNC was offering for one-year CD's at the time. At its Machinefinder.com Web site, Deere & Company held an auction for 15 pieces of used John Deere farm equipment that were gathering dust at its dealers' lots. And in a reverse auction, the Ford Motor Corporation's Visteon parts unit offered to buy from the lowest bidders $150 million in printed wire boards for climate control and braking systems. The company claims that the online auction brought considerable savings.

Corporate culture, channel management and pricing are just the tip of what companies face in creating an e-business strategy. Just as critical are such issues as branding, logistics, innovation, alliances and management. Answers for all of these challenges can be found in the one place that many companies hell-bent on the Internet are most reluctant to look - the real world.

Which is probably the most important lesson the physical space can offer e-businesses: If the real world were not relevant or viable, the Web would not be trying so hard to dislocate it.

FOCUS: LG SECURITIESFighting the Cannibals

by Glenn Rifkin

The explosive growth in online stock trading has not been a solely American phenomenon. As their economy rebounded in 1999, Koreans began to embrace online equity trading with a vengeance. With Korean stock prices rising, online commission rates plummeted through the first half of 1999. Despite these discounts, the value of trades placed online jumped from 5 percent of all trades in January to 30 percent in August 1999.

Korean consumers are now so enamored of online trading that many employers must limit Internet access in order to keep employees from playing the market all day.

LG Investments and Securities Company (LGS) has led the rush into the online trading world. With 90 branches and 1,900 employees, LGS is the $500 million brokerage services arm of the LG Group, one of Korea's largest conglomerates. Founded in 1969 and operating primarily in Korea, LG Securities is an unlikely company to have thrived in the fast-paced world of online trading. Growth over the past few years has been slow because LGS's C.E.O., Ho-Soon Oh, was reluctant to expand or hire new employees during the economic crisis that began in 1997, as were many of his competitors.

Despite a cautious corporate culture, Hong-Soop Song, an LG branch manager, saw a new market for the company in the burgeoning field of online trading. Because the Korean market was virgin territory, the first mover would undoubtedly enjoy a huge advantage. Why shouldn't it be LG Securities, he wondered. "Based on my knowledge of customer behavior as a branch manager, and my study of successful U.S. companies, such as E-Trade, I realized that online trading was a huge opportunity for us," Mr. Song says.

In November 1998, he presented Mr. Oh and C.F.O. Seong-Hyun Yoon with a proposal for a major online-trading initiative. He suggested a tenfold increase in spending on I.T. infrastructure for the online venture: New telecommunications lines and more powerful servers would be required. He also noted that the effort would require only a modest increase in employees, an attractive feature for executives who were loath to fire employees in another economic downturn. Mr. Oh and Mr. Yoon were so impressed by the proposal that they approved it in only two days - a miracle in a bureaucracy where major decisions usually take weeks or months - and allocated it a $15 million budget. The system was up and running one month later.

Beyond the speed of its development, LGS's online trading operation succeeded because it was convenient for customers. Because relatively few Koreans use the Internet from home, LGS targeted Korea's 15,000 cybercafe-like "PC Rooms," which offer high-speed online access for an hourly fee. LGS negotiated alliances with 700 PC Rooms, which eagerly promote LGS's trading services in the hope that they will increase their own revenues. LGS designed the online interface to be as simple as possible, and even dispatched staff to branch offices to explain the system and offer advice. Finally, LGS trumpeted the new service in a country-wide advertising blitz.

The initiative was not without obstacles. Unions are strong in Korea and the brokers' union protested that commissions would be cannibalized by online trading. When Mr. Song spoke with the union in November 1998, online commissions equalled those from the branches. But by January 1999, online commissions had dropped to a point a whopping 80 percent lower than branch trading commissions and the brokers feared for their livelihoods.

Mr. Song argued that since online trading was inevitable, it would be advantageous for the brokers if LGS got into the market first. Furthermore, he assured them that LGS was truly committed to the new venture and, in an attempt to sweeten the deal, he said LGS would tie brokers' income to online revenues: The more online trades placed, the more money the brokers would make.

One year later, the numbers have proved Mr. Song correct. Before the advent of online trading, LGS's 800,000 customers made about 40,000 trades per day in branches. Today, the number of trades has skyrocketed to 240,000 a day - with 40,000 still being placed at traditional branches. In the end, online trading didn't cannibalize LGS's income stream, but created an entirely new source of revenue by encouraging customers to place 200,000 more trades each day.

Reprint No. 00104

AuthorsMichael S. Katz, [email protected]Michael S. Katz is a senior vice president with Booz Allen Hamilton in New York. He specializes in media and entertainment, information technology, and e-business, working with clients in traditional publishing, recorded music, interactive media, television, and motion pictures.Jeffrey Rothfeder, [email protected]Jeffrey Rothfeder writes frequently for strategy+business and other leading business publications. His most recent book is Every Drop for Sale: Our Desperate Battle Over Water in a World About to Run Out (Penguin Putnam Inc., Jeremy P. Tarcher, 2001).

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